Politicians and commentators are responding to the increasingly dismal
economic forecasts with the usual call for "fiscal stimulus."
From the beginning of the New Deal to Bill Clinton's ill-fated pork-laden
stimulus package of 1993, this has been a hardy perennial trotted out
in lean times.

As measured by gross domestic product, the economy has barely been growing
for much of this year. Subtract government spending from the equation
and we find that the real arena of wealth creation, the private sector
economy, has actually been contracting. Something does need to be done
to restore prosperity and resume our national economic growth potential.

The answer, of course, lies in unshackling the American people to create
wealth and meet one another's needs within the context of the free market.
Government policy can assist this not by intervening more heavily but
by cutting taxes (especially marginal tax rates, which influence the relative
prices of work, savings and production versus leisure), restraining the
government spending that drives those taxes upward, repealing regulations
and keeping the dollar sound. That would in fact stimulate the economy
now while providing a backdrop for sustained prosperity in the long term.

Predictably, this isn't what is meant by stimulus when most politicians
are doing the talking. Even those who advocate the right policies often
do so for the wrong reasons. Many Bush administration economic advisers
sound as if they have taken Richard Nixon's dictum that we are all Keynesians
now to heart. They have been touting tax cuts not as a way to enhance
incentives, facilitate wealth-creation and enlarge production, but rather
as a means of getting money back into consumers' hands for them to spend
our way out of the impending recession.

O'Neill

Thus, we have the liberal Keynesians on the one hand arguing for the
government to increase spending as a way of getting the economy moving
again. This would include Robert Kuttner and Timothy Noah, the latter
the author of a ridiculous piece in Slate arguing that the rebuilding
necessitated by last month's World Trade Center attacks would somehow
be good for the economy in aggregate. Then we have the conservative Keynesians
arguing for the government to increase demand by cutting taxes, so that
consumers (and in fairness, also investors) can spend the economy back
into recovery. Examples of this include Treasury Secretary Paul O'Neill,
who the editors of National Review have rightly called upon to resign,
and supposed supply-sider Lawrence Kudlow, who writes for NR and is an
editor of the financial section of its website. According to William Anderson,
who teaches economics at Frostburg State University in Maryland and is
an adjunct scholar at the Ludwig von Mises Institute, Kudlow was actually
quoted in the New York Post talking about the "broken windows effect."

It is actually the "broken windows fallacy," first elaborated
upon by Frederic Bastiat. Just as it would be absurd to argue that it
is economically beneficial to throw a brick through someone's window because
they will have to pay to have it fixed, it is ridiculous to maintain that
the rebuilding effort in New York is a net plus for the economy. Yes,
some people will be made better off but the money and opportunity cost
being expended on this rebuilding effort detracts from other possible,
more productive uses of these resources elsewhere. Other projects will
die from lack of funding as resources are diverted to this effort. Anderson
writes about this at length in his essay, "Is Terrorism Good for
the Economy?"

The same is true of Keynesian economics generally, which is really just
the broken windows fallacy writ large. The money the government "injects"
into the economy through increased spending it first takes out of the
economy in taxes (or, if it is deficit spending, through borrowing). Any
alleged benefit this poses must be weighed against the other possible
uses of that money, especially considering private spending is more efficient
than public spending. It costs the public sector up to four times as much
to create a job as the private sector, some studies have indicated. New
projects go uncapitalized, investments are not made, and high-bracket
taxpayers forgo additional taxable income as marginal rates climb to fund
this so-called stimulus.

These assumptions rest on the false premise that consumer spending is
the key to economic growth when slumping consumer spending during a sluggish
economy is actually a derivative problem. The consumer cuts back spending
in anticipation of a decline in income or possible economic dislocation.
Consumer purchases cannot indefinitely be sustained without the wealth-creation
and production that generates the income necessary for such purchases.
When these decline, then consumer spending is threatened.

This is why any so-called stimulus that does not encourage the means of
production and wealth generation is doomed to fail, encouraging only bad
spending patterns by consumers and investors. They key is the amount of
real wealth available to support consumption, not the amount of credit
card purchases made in a vacuum.

Changes in depreciation schedules, slashes in tax rates and more judicious
domestic expenditures compatible with lower taxes generally can unleash
the creative spirits of the free market. Growing government in order to
grow the economy or worshipping consumption divorced from production will
only stimulate economic illiteracy.